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Dividends' Unintended Consequences

There are three unintended consequences on dividend stocks and
dividend investors being caused by the uncertainty of 2013 tax
rates. The consequences are an extraordinarily large number of
special dividend declarations, the early payment of typical
first-quarter dividends and the future adverse impact on dividend
growth rates for certain companies. These unintended consequences
are a subject we are discussing in the December
AAII Dividend Investing
monthly report, and I'll share an overview about them here.

Howard Silverblatt, the senior index analyst at S&P Dow
Jones Indices, counted special dividend (extraordinary
distributions that will not be repeated in the future) declarations
from 228 companies occurring last month. To put this number in
perspective, total annual (not monthly, but annual) special
dividend declarations have averaged 181 over the past eight years.
Only 2007 saw more declarations than November 2012 (233 for all of
2007 versus 228 for November 2012).

Whether paying a special dividend is a good thing is debatable.
If a company truly has excess cash on its balance sheet that is not
needed to fund future profitable projects, then distributing it to
shareholders is the right thing to do.
AAII Dividend Investing
holding Waddell & Reed Financial (
WDR
) is a company that is using its cash balance to fund a special
dividend.

Conversely, Costco (
COST
), a stock we do not hold, issued $3.5 billion in new debt to pay a
special dividend of $7.00 per share. Selling bonds to pay for a
dividend is akin to cashing one of those credit card checks sent in
the mail so you can have an expensive night out on the town. Well
after the joy of the night is gone, the repayment obligation
lingers.

Some companies are paying their typical first-quarter dividends
before December 31, 2012, to take advantage of known tax rates. For
individual investors holding these stocks (or those of companies
issuing special dividends), reported gross income for 2012 will
rise. Consult a tax professional if you have questions about the
implications on your tax liability.

The acceleration of payment dates also impacts future dividend
growth rates. By shifting a 2013 dividend payment into 2012, a
company risks having databases lower its annualized dividend growth
rate for years to come. Here's why. Assume a company paid a
quarterly dividend payment of $0.20 per share in 2012. In November,
the company raised its 2013 quarterly dividend payment to $0.22 per
share (a 10% increase), but shifted its typical January payment to
the end of December 2012. The calculations will show $1.02 in
dividends paid in 2012 (four payments of $0.20 per share and one
payment of $0.22 per share) and $0.66 in dividends paid in 2013
(three payments of $0.22 per share), a 35% decline in the annual
dividend growth rate.

The figures displayed on many websites and used in stock screens
will be calculated using the larger cumulative dividend payments in
2012 and the smaller cumulative dividend payments in 2013. This is
because the databases are not programmed to consider temporary,
tax-related actions. Expect to see the annualized dividend growth
rates for those companies that are paying their typical
first-quarter 2013 dividend before the end of 2012 reduced, or even
negative, for years to come. Also expect these companies to be
excluded from stock screens that require either consecutive annual
dividend increases or a minimum dividend growth rate. (The database
used for our
stock
screens
and our
Stock Investor Pro
screening software does not factor special dividends into the
dividend growth rate calculations. I cannot say with certainty how
other databases treat special dividends.)

Disclosure:
I am long [[WDR]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.

Additional disclosure:
WDR is held in the AAII Dividend Investing tracking portfolio.

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